Financial Fitness Is a Must
Mar 18, 2012
Taking care of cows and growing feed remains important. But the other essential part of the business today is understanding the numbers that drive the dairy.
By Gary Sipiorski, Vita Plus Corporation
I often mention to dairy producers at meetings that, in the past, the business of milking cows meant taking care of the cows and growing crops to feed the livestock. Everyone worked hard to get all of the chores done. Today everyone is still working hard, but there is another part of the business that takes more time than before. That other important part now is understanding the numbers that drive the dairy.
Before 1980, dairy producers in many cases had 50% of their milkcheck to pay operating expenses, and the balance could be used for capital expenditures. Hard to believe, but if you were there you know what I mean. At no surprise to everyone today, 85% of the milkcheck is used for operating expenses. That leaves only 15% of the check left for other purchases.
With tighter margins and no change in sight, dairy producers have to sit down and take time to know their numbers. Small margins can erode any profit in a hurry. Time needs to be spent during the day when a person’s mind is fresh, rather than late in the evening when the brain may not be as alert.
Financial fitness starts with doing and knowing your current balance sheet. It should be completed at the close of each year. The balance sheet contains the assets and liabilities of the dairy. The assets are broken down into current assets, which are cash, feed and items that will be turned into cash in 12 months.
The next parts of the balance sheet are intermediate assets of livestock and machinery. Real depreciation should be taken on machinery because it does wear out. Even if you put new tires on the tractor, it is not worth more the next year. That is called maintenance, and the tractor still needs to be depreciated in value. Then, long-term assets such as land and buildings are valued under long-term assets. Buildings should likewise be properly depreciated. Add these three columns up and one comes up with total assets.
The other side of the balance as it is known is the liability side. It starts with current liabilities, which are bills due over 30 days and principal due in the next 12 months. The intermediate liabilities are structured loans for cattle, machinery and lines of credit. The last parts of the liabilities are the loans for any real estate items. Adding the liabilities up, one comes up with total liabilities. Subtract total liabilities from total assets and the difference is your net worth or ownership equity. It is important to study and understand this important document.
The other half of the important financials is the income and expense cash flows. These are different than just having your taxes completed. Because agriculture runs on a cash basis, extra prepaid expenses can be run into a tax year to lower income. Unpaid bills will not show up in the expenses. Income can be moved from one year to the next, depending on when the checks are made out. It is important for a dairy producer to have a clearer picture of what income and expenses really do occur in a given year.
To be absolutely accurate, accrual adjustments should be made to the income statement. This means changes in feed inventories on hand. If there is less feed than a year ago, that is an accrual expense, because feed was used. If there is more on hand, that is registered as income, because cropping expenses were used to grow or buy the feed and it is available to generate income. Livestock accruals should be done in a similar way.
The current year income statement needs to be completed and studied. One major factor to be looked at is the cost of producing 100 pounds of milk. Just as a long-distance runner needs to know his or her time to improve, dairy producers need to know what that last 100 pounds of milk cost to produce. The last three years of the income statements need to be studied with all three years averaged out. A projected budget for the coming year needs to completed and tracked as the year moves on to see how projections match up. Make sure you spend extra time with the five major expenses and put some logic to the numbers.
If some of these terms are not real clear, hire yourself a trainer, such as a financial consultant or good accountant, to help you understand what financial fitness is.
Gary Sipiorski has a long career in the banking industry, doing business primarily with dairy producers. He has been associated with the Citizens State Bank of Loyal, the Graduate School of Banking in Austin, Texas, the Independent Community Bankers of America, the Governor’s Task Force on Growing Agriculture in Wisconsin, and the Advisory Council on Agriculture, Industry and Labor for the Federal Reserve Bank of Chicago. In 2008, he joined the Wisconsin-based nutrition firm, Vita Plus Corporation, where he is dairy development manager. Contact him at 608-250-4267 or GSipiorski@vitaplus.com.